We don’t know exactly what college will look like in the fall, but student loans to get there just got cheaper.
The interest rate on new undergraduate federal student loans will decrease to 2.75%, the lowest point on record, for the 2020-21 school year. That is a drop of 39% from 4.53% in 2019-20.
The government sets federal student loan interest rates based on yields from the U.S. Treasury Department’s auction of 10-year notes each May. Notes sold at the May 12 auction yielded just 0.7%, driven by investors willing to trade higher returns for lower risk. For comparison, last year's high-yield was 2.48%.
Undergraduate student loan rates are set by adding a margin of 2.05 percentage points to that yield; graduate loans are marked up by 3.6 points, PLUS loans by 4.6 points. That formula predicts these interest rates:
Undergraduate direct loans: 2.75%, down from 4.53%.
Graduate direct loans: 4.30%, down from 6.08%.
PLUS Loans: 5.30%, down from 7.08%.
These rates apply only to new loans for the 2020-21 school year and will stay the same for the life of the loan. Loans taken out prior to the rate change keep their original rate unless you choose to refinance privately.
Under normal circumstances, the lower interest rates might attract more students to colleges and universities. But COVID-19-related campus shutdowns, rocky household finances and transitions to online learning may decrease demand for enrollment this fall.
Impact of the new rates
The lowered interest rates mean new borrowers will see smaller monthly payments and decreased interest costs over the life of their loan as compared with last year’s interest rates.
Someone who took $5,500 in loans with a 10-year term at last year’s rate — 4.53% — could expect monthly payments of $57 and $1,350 in total interest costs. That same loan at the new rate would result in monthly payments of $52 and $797 in total interest.
Dependent undergraduates can borrow a maximum of $31,000 total in federal loans.
Parent PLUS loans have higher rates, and amounts tend to be larger — about $16,000 a year — because borrowing isn’t capped in a similar way. That gives the cheaper rates a bigger impact: A parent borrowing a typical amount would save about $15 a month and more than $1,700 by the time the loan is repaid compared with current rates.
Federal vs. private student loans
Undergraduate federal student loan interest rates are generally lower than rates from private lenders, and borrowers should exhaust federal borrowing before getting private loans.
Federal loans do not require a co-signer. But few undergrads have the credit history or income to get a private student loan on their own; more than 90% of private loans have a co-signer.
All federal student loan borrowers get the same interest rates. Private student loan interest rates vary based on the borrower’s credit and the term of the loan.
All federal loan interest rates are fixed. Private lenders usually offer both fixed and variable rate loans.